Flexible Savings Account vs. Health Savings Account

For some employees, the deadline for using the money in your flexible savings account (FSA) has passed. While some plans require that you use your funds by the end of the calendar year, some plans give you until March 15 of the following year to spend the money. So, for those with the March deadline, your chance to spend FSA dollars for the previous year – or lose them – has already passed. One of the reasons that employees leave an average $86 (according to Kiplinger) in their FSAs could be that they aren’t fully aware that this money doesn’t roll over like health savings account (HSA) contributions do.

Keep Your Funds: Biggest Difference Between a FSA and a HSA

Like the flexible spending account, a health savings account features tax-deductible contributions. You set aside pre-tax money for health care expenses, tapping your account when you need to spend money on qualified costs. As long as you use your money for qualified health care expenses, you don’t have to pay taxes on your contributions (and your earnings in the case of a HSA, which operates like an IRA).

Rules for what constitutes a qualified health care expense are similar for FSAs and HSAs, including the new rules that require you to have a prescription for over the counter medicines that you want to pay for using health account funds. There are some differences between the two accounts, though. The biggest difference between the FSA and the HSA is that you can roll your money over year to year with a HSA.

A flexible spending account requires that you use the money you set aside each year – or lose it. If you don’t spend it all, it is lost. With a health savings account, though, the story is different. The money rolls over, so it accumulates year after year. In the end, as long as you meet the rules for withdrawing from an IRA, you can even take distributions for non-medical costs (you will have to pay taxes, though).

Other Differences Between HSAs and FSAs

Qualifying for a HSA is a little different from qualifying for a FSA. You must be paying for a high deductible health insurance plan if you want to set money aside in a HSA. This means you might have higher out of pocket expenses – but a lower insurance premium. With the flexible spending account, it might just be part of your employer’s health plan. You don’t even need a health plan to participate in a FSA.

Additionally, with a FSA, you can actually use the money to pay for dependent care expenses, such as childcare or elder care. This is not possible with a HSA. In some ways, as long as you know that you can use the money in your FSA, the flexible spending account is more versatile than the health savings account. You should also be aware that if you have a chronic condition or spend a great deal on health care, a HSA might not be the best choice since you will be paying more out of pocket.

Choosing between the two is largely a matter of your personal finance situation, and your preference. Before deciding, though, you should understand the main differences between the two so that you know what will work best for you.

Here’s the dirty secret about FSA’s which NO ONE will ever tell you, not your employer and not even the journalists:

An FSA is a “Pre-Funded Account”. That means that beginning on the first day of the plan year, ALL of the money is immediately available. All of it… without any regard for how much has been deducted from your paycheck (as long as the submitted expenses are qualified). AND MOST IMPORTANTLY, without any regard for how many paychecks you have received during that year.

A pre-funded account is like a bet being made by BOTH employee and EMPLOYER. The employee is betting that they will have enough qualified expenses to use up what is being deducted. BUT the employer fails to tell you that they also are betting. Your employer is betting that you will work through the end of the plan year so that they can recover the full amount through payroll deductions.

However, if you do not complete the year, the employer CANNOT force the employee to repay any overages. In order for the employer to receive the advantages of offering an FSA, both employee and employer must take on “equal” risks. Employee must use all of the money before the end of the plan year, AND the employer must provide a paycheck through the end of the plan year.

So, imagine its September 1 and your $3,000 FSA has just started. In October, your FSA reimburses you for $3,000 in medical bills. In December, your employer lays you off. You are not required to pay the difference between the $1,000 in payroll deductions collected so far, and the $3,000 that was already paid out.

I know this because I’ve done it. My employer laid off half of the staff, and I knew my department was going to get sold and that I was next on the chopping block. So, I maxed out my spending before my last day. I received my full benefit without my employer receiving the full year of payroll deductions. No one ever brought it up and no one suggested that I had to reimburse anything.

Of course, this only works if you know you will be leaving early, either because you are quitting or you are made aware of a pending layoff.

Is this ethical? ABSOLUTELY… because remember that the FSA is a BET being made by both employee and employer. Remember, employers are smart people and they know that every year there will be a certain number of employees who fail to use up the full amount. They are already benefiting from the bet: they get to keep this unused, un-paid out portion. You have a moral right to do exactly the same and use up your full benefit BEFORE the end of your paychecks.

(Also, you need to ask yourself: WHY doesn’t the employer EVER explain this part of the FSA to you? And ask yourself is it ethical for the employer to withhold this information from you when you are making your decision whether to signup or not. I suggest that it is the employer who is not being ethical here.)

Don’t believe me? Read up on it. Start by looking up FSA on Wikipedia, then do a google search for “FSA Pre-Funded Account”. Read a few of the web pages.

I keep reading that FSA money goes away if you dont use it… but no one tells me where my money goes…. Does it go into the company handleing the account? That sounds like legal theft to me. Does it pay down the deficet? Does it fund an entitlement program? Does my employer get it?

Where does the money I earned that I put into a FSA go if I don’t use it? Who gets to keep MY money? I’m sure its not just zero’d out and the money is just lost to the world…. Why is it not returned to me and I just pay the tax on what is returned?

@Justin, Good point for those self employed folks. We’re in the middle of a job transition and are going for the COBRA option for the few months without employer insurance. I don’t think we could use either a FSA or an HSA in this instance.

I still find HSA’s are better than FSA’s, I wrote an article about this recently myself. HSA’s allow you to spend less in monthly insurance premiums because its a high deductible plan, and you contribute with tax free money…that being said, it’s A LOT better if your employer contributes as well.

Nice overview from the article and last commenter. I was always disturbed by the fact that the fsa disallows rollovers of the funds from year to year. Although, if you use up the funds annually, the savings can be substantial.

First what you’re talking about here is a HEALTHCARE FSA, which is probably the most common form of FSA. But an employer can offer an FSA for other things – like transit, parking, wellness, and so forth. FSA simply stands for Flexible Spending Account.

Second is that that choosing between the two is NOT actually just figuring out which is better. An individual cannot open a healthcare FSA. A healthcare FSA has to be provided by your employer as part of an employer run cafeteria plan. If your employer doesn’t provide a healthcare FSA (line mine doesn’t), then you can only open up an HSA, and then only if you have a high-deductible insurance policy (the IRS limit is $1200 for individuals).

Finally, you are incorrect that the HSA cannot be used to cover dependent expenses. From IRS publication 969 on HSAs:
Qualified medical expenses are those incurred by the following persons.
You and your spouse.
All dependents you claim on your tax return.
If you’re talking specifically about childcare/eldercare, that’s not covered under a healthcare FSA or an HSA, unless you specifically set up a dependent care savings plan.

I just did a ton of research on the options myself before opening up my own HSA, so I’m pretty current on the topic.

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